Garmin Cashes in on Holiday PND Sales

Portable Navigation Devices [PNDs] were clearly a “hot” item over the holiday season, and Garmin (GRMN) benefited as expected. Sales within Garmin’s automotive/mobile segment, nearly 73% of the corporate total, increased by 173% to $445 million, measurably eclipsing the 112% increase we were anticipating for the unit’s year-over-year growth. The outdoor segment increased by 16%, in-line with estimates, but the aviation and marine segments continued to struggle posting a 3.6% increase and a decline of 11.3%, respectively.

Management’s initial revenue guidance for 2007 was very strong, with sales targeted at $2.5 billion, representing 41.3% year over year growth (Street consensus was $2.2 billion). Management believes that all businesses will perform well, with the outdoor, aviation, and marine segments targeted for 20% top line growth, and the automotive segment expected to generate better-than 50% revenue growth for the year.

In general , analysts view management’s assessment of 2007 to be quite plausible. But, given the chronic underperformance in 2006, they are somewhat circumspect regarding a quick turnaround in the marine and aviation segments since they have yet to show any meaningful signs of fundamental traction. So, given aviation’s higher-than-corporate-average margins, that segment could prove to be a pivotal swing factor in 2007’s outcome. If it performs to management’s expectation, it could conceivably mask weakness elsewhere, perhaps in the automotive segment, where either share loss or greater than expected margin contraction is not out of the question ( For now, we have modeled for a mix favoring the automotive segment with revenue growth estimated at 57%).

Analysts have positive expectations for the PND segment that remain unchanged, still expecting that 25 million PNDs will be sold in 2007, 8 million units in North America and 17 million units Europe. But, given Garmin’s expanded capacity, and apparent willingness to endure lower margin, they may in fact be able to maintain share in Europe at 15% - 20%, and will lose only moderately in North America to 35% - 40%, where volume growth will continue to salve earnings. Garmin’s growth in the PND segment is tied to pricing. If Garmin intends to maintain market share, margin will have to decline, perhaps materially. And, indeed, it appears that, in 2007, this inverse relationship between share and margin will be very pronounced.

But, curiously, in the fourth quarter of 2006, margins not only held steady, but actually widened. Corporate gross margin of 49.8% was 180 basis points better than we had expected, with the variance attributable to a $17 million credit from suppliers relating to the achievement of certain full year unit thresholds—rebates of a sort (Thus, if we were to adjust for this one-time credit, gross margin would have been 47%, or 100 basis points below original estimate.)

The automotive segment was the principal beneficiary of this supplier credit, and, therefore, it could be argued that this quarter’s segment gross margin of 46% is unsustainable. In fact, gross margin will decline by nearly 600 bps year on year in 2007. Management believes that ASPs will decline by approximately 25% (That mix and declining materials costs will give gross margin a boost of approximately 12%, resulting in an overall decline of approximately 13.5% per
year over the next two years.) But, margins will benefit from mix improvement and reduction in the overall costs for their bill of materials (Garmin’s most expensive components are: LCD screens, digital mapping, flash memory, and GPS chipsets.)

Operating margin will continue to contract, it seems, due to the impact of gross margin decline and an increase in spending to support a larger product development and sales footprint. Management is now targeting $150 million in advertising costs, up from $115 million in 2006, and $140 million in R&D expense, up from $113.3 million this year. While these investments are essential to remain competitive, we continue to question whether consumers are persuaded simply to purchase a PND (at the right price), or a branded Garmin PND. Is an element of price elasticity beginning to creep into this market?

Drawing an analogy between the ipod and the nuvi, many argue that Garmin maintains a loyal consumer following similar to that attributable to Apple. But, analysts remain somewhat more skeptical, pointing to recent industry data that seems to support the notion that, in the several weeks subsequent to Black Friday at least, a competitive product – the Mio-- was able to pick up share simply by pricing at deep discounts to Garmin (this premise seems to have been validated in almost all channel checks across numerous geographies and retail channels).